ACE 8021: Sustainable Development & Environmental Change

Some Economics

<>Semester 1, 2011.  

Thursday 10th November, 09.00 - 10.00, Bedson TC, B.32 & 15.00 - 16.00 Agric. Bldg. 3.02

Prof. David R. Harvey, AFRD, October, 2011.

The Curriculum Brief: "Measuring Sustainability - Economic Indicators" However, there is no sensible way of listing or discussing economic indicators without an appreciation of economic systematics.

Hence, these short notes deal with: Cost Benefit Analysis & Externalities; Discounting; Carbon Accounting & Pricing - [including the Stern Report and Climate Change (the 'elephant in the room') and the 'ultimate' challenge to CBA]

1.    Cost Benefit Analysis:

Basic Refs:  OECD: 2007 Policy Brief: Assessing Environmental Policies;
OECD, Cost Benefit Analysis & the Environment - Recent Developments, 2006 (Executive Summary)
 
Principles: 
Implications (Key Questions):
Why is it necessary? 
Note: the general efficiency of the market system is derived from a consideration of the general equilibrium of a society with limited resources and, therefore, the need to choose between alternative outcomes (how much to produce, of what, for whom?) - there is no such thing as a free lunch.  This general equilibrium between the productive capacity of the economy (its production possibility frontier) and the social preferences for the products and services (the indifference or utility map, reflecting the social welfare function) generates a set of (shadow or implicit) relative prices for all goods and services, which reflect both the opportunity costs of producing one good in terms of another (the 'supply' price) and the rate at which consumers and users are willing to trade off one with another (the 'demand' price).

In equilibrium, these supply & demand prices will be equal; supply curves (the relationship between quantities supplied and prices necessary to recompense the suppliers) slope upwards (higher prices needed to secure additional supplies of any one good or service); demand curves (relating the quantities demanded by consumers and users with the prices they are willing to pay (in terms of giving up other goods and services) slope downwards. Furthermore, it follows that communities, regions, countries etc. will be better off specialising and trading with each other (according to their comparative advantage) than trying to be self-sufficient. (See here for more explanation of this general economic theory)

Hence, CBA is generally required when markets fail - they do NOT generate the socially desirable outcomes, and we need to assess what the desirable outcomes are, and the extent to which they are more desirable than what otherwise occurs.  The major market failures are:  externalities;  public goods.

What are its limits?  There are many practical difficulties with implementing CBA (below), but a principal limitation is that the necessary accounting in terms of money units necessarily assumes something about the value of money itself to each and all the affected parties (which, typically, is everyone in society in one way or another,  as either consumers and/or taxpayers (tax recipients)) - everyone, ultimately, is a stakeholder in everything.  The traditional presumption is that DISTRIBUTION DOES NOT MATTER (that £1 worth of gain to one can be treated as exactly commensurate with £1 worth of cost to another).  It follows, then, that the losers from a project or policy can, at least in principle, be compensated by the winners (the costs can be covered by the benefits) and still leave everyone better off than before - the benefits exceed the costs, which might mean making the rich richer and the poor poorer (unless the losers are actually compensated). CBA is NOT (ordinarily) concerned with EQUITY of outcome. 

However, more modern and sophisticated applications (see, e.g., OECD, 2006, above) now DO take some account of equity and distribution, by weighting the poors' costs and benefits at a higher rate than the rich (because an extra £1 is of more value to the poor than to the rich (though this leaves on one side the question of whether the poor can be expected to use their extra £s more 'socially responsibly' than the rich)).

What does sustainability mean?  You already have a number of definitions - but here is one which you may not have seen before:  "Note also that the (Bruntland) Commission's definition is directed at sustaining the factors that go to meet needs. In their view "sustainable development" requires that relative to their populations each generation should bequeath to its successor at least as large a quantity of what may be called an economy's "productive base" as it had itself inherited from its predecessor. That raises another problem with the Commission's reasoning: it does not explain how the productive base should be measured.
We take the view that economic development should be evaluated in terms of its contribution to intergenerational well-being. Specifically, we identify sustainable development with economic paths along which intergenerational well-being does not decline. In view of what is already known about the relationship between real national income and social well-being in a timeless economy, we should expect that there is a measure of an economy's productive base that reflects intergenerational well-being. We show below that intergenerational well-being would not decline over a specified time-period if and only if a comprehensive measure of the economy's wealth were not to decline over the same period. By wealth we mean the social worth of an economy's entire productive base. Because the productive base consists of the entire range of factors that determine intergenerational well-being, we will sometimes refer to wealth as comprehensive wealth.
What are the raw ingredients of wealth? It is intuitive that an economy's productive base comprises the entire range of capital assets to which people have access. Wealth therefore includes not only reproducible capital goods (roads, buildings, machinery and equipments), human capital (health, education, skills), and natural capital (ecosystems, minerals and fossil fuels); but also population (size and demographic profile), public knowledge, and the myriad of formal and informal institutions that influence the allocation of resources. We will see presently that reproducible capital, human capital, and natural capital enter quantitative estimates of sustainable development in a somewhat different way from population, public knowledge, and institutions."  (Arrow et al. November, 2010, p2)


Key Problems and Issues:
The justification for discounting is twofold:
 To compare any future benefits with present options, therefore, implies that the future benefits should be discounted to their present value using the interest rate (r* below) to be earned on the alternative secure investment opportunity (the rate of interest  earned on government bonds, say).  However, there are major questions to be asked about what the appropriate discount rate is, and, especially, whether this rate should be constant - applying equally to all future dates.  There is, as we shall see below, particular dispute about the appropriate discount rate to use for inter-generational comparisons (long lived or far off effects and costs).
Note on Intergenerational Discounting:  We can presume a social welfare function, in which social welfare is a function of consumption (in turn depending on income and production). If the welfare function is assumed (for convenience) to exhibit a constant elasticity of marginal utility of consumption (see below) , and we also assume a constant population and a constant rate of growth of consumption (g) per generation, then the appropriate social discount rate, (sometimes referred to as the Utility or Consumption discount rate) δ, by which consumption of future generations (and thus their income and costs) should be discounted is classically expressed as:

δ = ρ + gη (sometimes known as the Ramsey equation after the economist who first derived the expression, in 1928)
Notice, especially, that this classical social discount rate refers to comparisons between generations, and not to individual time preference rates or utility functions (preference behaviours or attitudes).
For example,  Pearce and Ulph, 1995, argue that a rate of between 2 and 4%  is appropriate, with the lower end of the range being more defensible - incidentally quoting Stern himself (see below) in an earlier incarnation as arguing for much higher rates.

2.    Climate Change - the ultimate challenge to CBA?

The Stern Review: The Economics of Climate Change, 2006, is probably the most prominent "CBA" ever conducted, to examine the issue of what should be done about Climate Change.

There is, of course, a number of issues involved:
  1. Is climate change happening or likely to happen?
  2. If so, is human activity the cause?
  3. What are the possible consequences if we do nothing about it?
  4. What can be done to mitigate CC, and what are the costs?
  5. What are the costs (and benefits) of simply coping with it?
  6. What, then, should we be doing?
  7. Why are we not doing this already and what needs to change or be changed for the appropriate social and human response?
The science :  Notwithstanding the complexity, and hence essential unpredictability of the global climate and feedback systems, the International Panel on Climate Change (IPCC) reports (from the IPCC's 4th Assessment Report, 2007, Summary for Policymakers) that:
The answers to questions 1 & 2 are yes and yes, according to the IPCC and many others.  But, see below.
The IPCC uses a set of possible scenarios (SRES) depicting world growth and development trajectories:
Under these scenarios, the projections of global warming are as follows (from the Policymakers Summary, p 10, SPM.7, lower panel)

[Dots and bars indicate the best estimate and likely ranges of warming assessed for the six SRES marker scenarios for 2090-2099 relative to 1980-1999.]

This level of warming will, according to the IPCC, have considerable effects (see report).  In particular "Altered frequencies and intensities of extreme weather, together with sea level rise, are expected to have mostly adverse effects on natural and human systems."

In addition: 
The IPCC report includes assessments of the consequences (see report, p10ff), some of which may be positive (e.g. increased cereal productivity in the temperate latitudes for at least a limited degree of warming, though declines for more substantial (>3oC warming)), but mostly negative c.f. present conditions. It also warns of the increased possibilities of abrupt and irreversible changes, such as melting of the Greenland (and West Antarctic) icecaps, raising sea levels by 6-7 metres, and exacerbating warming to + 5 - 6oC, or, less likely but possible, the elimination of the Gulf Stream.  The Stern Review draws implications and conclusions from existing research, rather than conducting new research.  Furthermore, it is a government report, rather than a traditional scientific study, and was produced very quickly (for what it is). As Nordhaus (below) notes: "it is not a standard analysis" but a government report which emphasises the facts and evidence (including previous research) which supports the required conclusion - to do something about climate change, and was not subject to the usual scientific processes of peer review prior to publication, nor is strictly reproducable (the analysis is not sufficiently elaborated as to be replicable) - in part, because it is a 'review' and not a stand-alone, independent analysis. It has drawn a considerable amount of criticism and 'peer review' since publication.  The following notes distill the key aspects from some of the reviews:

The Social Science?  - The Stern Review (SR), and reviews of the review.
  1. What are the possible consequences if we do nothing about it?
  2. What can be done to mitigate CC, and what are the costs?
  3. What are the costs (and benefits) of simply coping with it?
  4. What, then, should we be doing?
  5. Why are we not doing this already and what needs to change or be changed for the appropriate social and human response?

Critical Factors in assessing/recommending Climate Change policies
Consequences of doing nothing (according to Stern) : 
** Note:  However, Tol & Yohe point out (p 237) that this particular model is rather atypical of such models in two important respects: a) PAGE allows for only a 5% probability that CC effects are net positive in the short run, while other models of this type put the probability at closer to 10%; b) PAGE assumes that vulnerability to CC is independent of development, though we 'know' that adaptive capacity and, thus, net sensitivity to CC is very site specific and path dependent - it does depend on development.]
Cost of doing something:  Stablising emissions at 550ppm CO2equivalent (which could limit increasing temperatures to 2-3oC) requires global emissions to peak in the next 10 - 20 years, and then fall at at least 1 - 3% per year (from present (2000) emissions of 40Gt CO2e peaking at about 60, and then falling to 20 Gt CO2e by 2100. Bottom line:  costs @ 1% GDP versus benefits of the order of 5 - 20% GDP = very strong case to do something (a lot) now. CB ratio of 5 - 20:1.  Alternatively, SR estimates (preliminary calculations) that the BAU costs are "of the order of $85 per tonne CO2e" (p xvi), while starting "in the region of $25-30 per tonne CO2e" to achieve a target of 500ppm (p xvii), where the "social cost of carbon is likely to increase steadily over time because the marginal damages increase with the stock of GHGs in the atmosphere, and that stock rises over time."  [But this seems to imply a rather lower CB ratio (85/27.5 = 3:1)]

Key Points of contention.
 Climate Change & effects are exaggerated?
Acknowledgment of the "fact" of climate change due to anthropogenic (human) causes is not unanimous. Plenty of people, who should know, dispute the concensus.  A flavour of the reasons for being doubtful can be seen from a look at the global carbon balance (from the Woods Hole Research Centre, (One Pg [petagram]=one billion metric tonnes=1000 x one billion kg)

Notice, first,  how relatively small in comparsion with both sinks and other flows are the flows of Carbon into the atmosphere from the buring of coal and gas (the major anthropogenic sources of carbon emissions, apart from changes in land use, such as the burning of forests and cultivation of 'virgin' soils etc. - at about 1.5Pg/year).  It is interesting to note, also, that one person breathing for a year produces, on its own, about 1 tonne of CO2, which with a global population of, presently, about 6 billion, translates to approximately 2Pg per year, rising inexorably to 3Pg by 2050 as the world's population grows.

Second, as noted by the Woods Hole Research Centre, "Attention on the global carbon cycle over more than 30 years has focused on the apparent imbalance in the carbon budget - the so-called "missing sink," missing because the accumulation of carbon has not been observed. The average annual emissions of 8.5 PgC during the 1990s (6.3± 0.4 Pg from combustion of fossil fuels and 2.2± 0.8 Pg from changes in land use) are greater than the sum of the annual accumulation of carbon in the atmosphere (3.2 ± 0.2) and the annual uptake by the oceans (2.4 ± 0.7 PgC/yr). An additional sink of 2.9 PgC/yr is required for balancing the budget."

Third, Global warming is also a consequence of changes in solar activity, and (McKitrick), and there is room to doubt that the present 'concensus' account of the influence of changes in solar activity over the recent past is as reliable as suggested by the IPCC.  There are also (McKitrick notes) strong reasons to question the particular measurements of ground level temperatures and trends used by the IPCC to demonstrate the recent warming.

The Fourth ground for questioning the IPPC concensus, also documented by McKitrick, is, perhaps, the most critical. The evidence might not match the models (though see here for some papers about the correspondence).  According to the Global Climate Models representation of the climate system, the one unique signature of  CO2 forcing of climate change (global warming) is a significant rise in the tropical tropospheric temperature, which does not occur as a consequence of solar radiation change. However, there, as yet, no sign of this supposed signature actually happening in practice. As McKitrick notes (p 14) quoting the US Climate Change Science Programme: "For global averages, models and observations generally show overlapping rectangles. A potentially serious inconsistency, however, has been identified in the tropics. .. the lower troposphere warms more rapidly than the surface in almost all model simulations, while, in the majority of observed data sets, the surface has warmed more rapidly than the lower troposphere. In fact, ... the models that show best agreement with the observations are those that have the lowest (and probably unrealistic) amounts of warming."  As McKitrick comments: "Take out the “probably unrealistic” gloss and this is an admission of something pretty significant. The IPCC makes almost no mention of the issue. Had there been evidence of rapid warming in the tropical troposphere, the data would have been presented in a prominent format, accompanied by extensive discussion. The decision to downplay this topic is another indicator of the biased editorial hand guiding the final report."  McKitrick concludes: "the core writing team of the IPCC Report shares a single point of view, that its members are alert and predisposed towards evidence that confirms it, and they are unreceptive or openly hostile to evidence that contradicts it. Whether the reader agrees or not, take it as read, for the moment, that there is a problem of bias."  See Here for an independent summary of the IPCC evidence (hosted by Ross McKitrik).

The damage of climate change:  SR Estimates $314/tC ($85/tCO2) versus other estimates ranging from $50/tC - $360/tC. 
Putting these figures into context, $50/tC is about equivalent to $12/barrel of oil while $360/tC is about $84/barrel of oil ($200/tC = $47/barrel)  The world oil price has climbed from about $40/barrel in 2006 ($20 in 2003) to > $100 in 2008, and has now fallen back to $86 (October, 2008)
Are the damage estimates of BAU extreme? SR is often criticised (e.g World Economics reviews below) for taking the most pessimistic estimates for both the biophysics of climate change and of the human consequences, and of taking too little account of adaptation to climate change, or technological developments to cope with change (including not accounting for  developments in existing health and productivity for, especially, the poor, which are necessary anyway, regardless of CC). Further charges are that SR is inconsistent in its assessment of different sorts of damages and their costs, including double counting the risk of catastrophic events (hurricane damages etc.), and presuming that the costs (risks) associated with uncertainty about actual climate change and its effects do not diminish with time, as we learn more about the effects and reduce the uncertainty.  In any event, the damage estimates used by SR are considerably greater than existing economic assessments of the costs of climate change (which range between -2% (a net benefit) to +5% GDP) - Tol and Yohe)
SR reports marginal damage costs (see above) as $85 per tonne CO2e, as the cost of an additional emission of another tonne, which is equivalent to $314/tC (Tol & Yohe), which is an outlier in the marginal damage cost literature on climate change (e.g. Tol, 2005, The marginal damage costs of CO2 emissions: an assessment of the uncertainties", Energy Policy, 33 (16), 2064 - 2074). Even given SR's very low discount rate (see below), SR's damage costs are high - that is, when other estimates are adjusted to the same low discount rates, other studies report marginal damage costs of about $200/tC, with a range from about $50/tC to $360/tC. Without adjusting for the extreme discount rate, SR's estimate is at the extreme edge of all studies estimates (up to Dec. 2006), including those which have not been peer reviewed (Tol and Yohe). 

The costs of mitigation:   SR @ 1% GDP (truncated) versus range of 0 - 7%GDP (permanent).  Tol and Yohe report that SR's range of emission reduction costs (centering on 1% GDP) is lower than the range of costs reported (for instance) in the latest results from the Energy Modeling Forum (EMF21) survey of multiple models, which range from 0 to 7% GDP, with a mean of 2%.  For 2050, EMF21 average cost is 2.2% GDP (though lower at 1.4% if other GHGs are included as well as CO2).  Furthermore, and perhaps even more importantly, SR truncates the costs of mitigation at 2050, and does not consider costs beyond this date (by which emissions are supposed to be stabilized at 550ppm).  EMF21 results show average costs rising to 6.4% (4.8%) by 2100. 

In fact, the major source used by SR for its cost estimates has (worryingly) costs falling from now until 2050 (from $360/tC in 2005 to $96/tC in 2050). In contrast EMF21 shows these costs rising (and, incidentally, being much more uncertain) from a very low level to $360/tC (range 0 - $1850/tC). Costs should rise through time, not fall, if the discounted costs of achieving any climate change target are to  be minimised - economic efficiency requires that policies or strategies to reduce emissions start now modestly and become progressively more stringent through time, with progressively more substantial reductions in the medium to longer term - this result follows because: a) the discounting of the future, but, more importantly because b) technical progress, the need to replace capital and the carbon cycle itself all work in favour of rising abatement costs through time from now.  In short, SR uses an apparently sub-optimal abatement cost.  Coupled with the discount rate used (see below), this treatment of costs of mitigation (low underlying costs, declining costs, and truncation of the horizon) produce substantially lower abatement costs than the existing literature suggests.

The discount rate: SR is low, cf most others. Stern applies a Social time preference rate of 0.1%, (extremely low by conventional standards - more usually 1 - 2% or greater), which is then combined with a consumption elasticity of 1 (more typically 2 or 3) and assumed growth rates of 2, 1.8 and 1.3% per head per annum over the next three centuries respectively, producing (according to the Ramsey formula above) discount rates of 2.1, 1.9 and 1.4 for the next three centuries respectively (though these rates have taken some additional enquiry to recover, since they are not actually made explicit in the SR (see Byatt et al (below), p 212). [Under more conventional assumptions about the consumption elasticity and social time preference rates, the discount factor would be more like 4%]

As a result, Stern produces very high estimates of the present values of the damage of future climate change. While this low discount rate should also increase the present values of the costs of mitigation, this counterbalance is less pronounced in SR because of the truncation of the costs considered to 2050. This has been widely criticised (all the reviewers listed below and many others).   

Most economists think that  ρ, the social rate of time preference, is greater than zero (or 0.1%, as assumed by SR) - otherwise we would observe people devoting very much higher fractions of their income to savings for the future that we, in fact, observe (though, note, we are talking, here, of a social rather than personal time preference rates, and, furthermore, appeals to investment behaviour theories sound somewhat hollow when these theories cannot, presently, account for the 'equity premium' or 'risk-free rate of return' puzzles).

Ken Arrow (below, p 4-5), however, makes the following compelling argument (my emphasis added):  "Many have complained about the Stern Review adopting a value of zero for ρ , the social rate of time preference. However, I find that the case for intervention to keep CO2 levels within bounds (say, aiming to stabilize them at about 550 ppm) is sufficiently strong as to be insensitive to the arguments about ρ . To establish this point, I draw on some numbers from the Stern Review concerning future benefits from keeping greenhouse gas concentrations from exceeding 550 ppm, as well as the costs of accomplishing this.

The benefits from mitigation of greenhouse gases are the avoided damages. The Review provides a comprehensive view of these damages, including both market damages as well as nonmarket damages that account for health impacts and various ecological impacts. The damages are presented in several scenarios, but I consider the so-called High-climate scenario to be the best-based. Figure 6-5c of the Review shows the increasing damages of climate change on a “business as usual” policy. By the year 2200, the losses in GNP have an expected value of 13.8% of what GNP would be otherwise, with a .05 percentile of about 3% and a .95 percentile of about 34%. With this degree of uncertainty, the loss should be equivalent to a certain loss of about 20%.

The base rate of growth of the economy (before calculating the climate change effect) was taken to be 1.3% per year; a loss of 20% in the year 2200 amounts to reducing the growth rate to 1.2% per year. In other words, the benefit from mitigating greenhouse gas emissions can be represented as the increase in the growth rate from today to 2200 from 1.2 % per year to 1.3% per year.

We have to compare this benefit with the cost of stabilization. Estimates given in Table 10.1 of the Stern Review range from 3.4% down to -3.9% of GNP. (Since energy-saving reduces energy costs, this last estimate is not as startling as it sounds.) Let me assume then that costs to prevent additional accumulation of CO2 (and equivalents) come to 1% of GNP every year forever.

Finally, I assume, in accordance with a fair amount of empirical evidence, that η, the component of the discount rate attributable to the declining marginal utility of consumption, is equal to 2. I then examine whether the present value of benefits (from the increase in the GDP growth rate from 1.2% to 1.3%) exceeds the present value of the costs (from the 1% permanent reduction in the level of the GDP time profile).

A straightforward calculation shows that mitigation is better than business as usual — that is, the present value of the benefits exceeds the present value of the costs — for any social rate of time preference (ρ) less than 8.5%. No estimate for the pure rate of time preference even by those who believe in relatively strong discounting of the future has ever approached 8.5%. These calculations indicate that, even with higher discounting, the Stern Review’s estimates of future benefits and costs imply that current mitigation passes a benefit-cost test. Note that these calculations rely on the Stern Review’s projected time profiles for benefits and its estimate of annual costs. Much disagreement surrounds these estimates, and further sensitivity analysis is called for. Still, I believe there can be little serious argument over the importance of a policy of avoiding major further increases in combustion by-products. "

Note, this is in distinct contrast to the Nordhaus review, which casts major doubt on the assumption:  "The Review's radical revision of the economics of climate change does not arise from any new economics, science, or modelling. Rather it depends on the assumption of a near zero time discount rate combined with a specific utility function. The Review's unambiguous conclusions about the need for extreme immediate action will not survive the substitution of assumptions which are more consistent with today's marketplace real interest rates and savings rates. Hence the central questions about global warming policy - how much, how fast and how costly - remain open." (p 701)
[Note, however, that SR does not actually use a discount rate of near zero - just a pure time preference rate of near zero (0.1%).  The actual discount rates used are 2.1, 1.9 and 1.4 for the next three centuries, respectively - see above]

Comparability of Costs and Benefits
Tol & Yohe (below) note that SR's estimates of the damage of climate change are "about eight times those of the CEC (2005)*, while abatement cost estimates are only about four times as high. Nonetheless, SR advocates a climate target that is less stringent than does CEC and devotes no effort to explaining the discrepancy." (T&Y, below, p. 240).
* CEC (2005): Winning the battle against global climate change, Communication from the Commission to the Council, the European Parliament, the European Economic and Social Committee of the Regions COM (2005) 35 final, Commission of the European Communities.

Conclusions and Implications (DRH).
What follows are my own current conclusions about climate change and SR in particular,  I have not (yet) read or thoroughly understood all the issues and literature on this topic (and probably no one life is long enough to do so), but I consider that I am sufficiently well acquainted  with the general principles and issues that I can reach some interim conclusions.  The most insightful and helpful assessment of SR that I have yet read is Weitzman (JEL, 2007), which I strongly recommend, though it is tough read for non specialists.

While many reviewers of SR are highly critical of the particular assumptions and choices of damage and abatement cost estimates from the literature, there remains a reasonable consensus (with some remaining dissenters) that there are sound reasons to do something now, and probably more in the near term to avoid the potential for  serious damage in the future as a consequence of man-exacerbated climate change.  However, SR appears to argue strongly for immediate and severe action to deal with the problem, which is in distinct contrast to the conventional economic analysis of the problem which recommends limited action now but progressive 'ramping up' of action through the medium to long term (20 years from now?).  In this sense, SR has been labeled ' alarmist', and has been heavily criticised - which could undermine the central message that CC is important and that something needs to be done.

Tol & Yohe note that the economics of exhaustible resources is applicable here - delay cannot be an optimal (least cost) approach - we are already adding to cumulative damage, and any delay increases that damage (and hence the costs of coping with or ameliorating it).  In short, we are already in a hole, and we should stop digging now, since the hole will become more, possibly very much more, uncomfortable and profitable the more we go on digging.  To argue otherwise requires that we be certain that:
 Since there are no serious scientific grounds for any of these 'certainties', and every reason to suppose the contrary - we need to start doing something about it now, especially since, if anything, new and more recent science strongly suggests that climate change is happening faster and effects will be felt sooner than previously thought.  I (for one) still believe that this is the case, despite the strong arguments (see, especially, McKitrick) that the IPCC has become heavily politicised and that its evidence base for the proposition that global warming is actually anthropogenic (caused by human activity) is suspect. Even so, it is surely taking an unacceptably big risk to believe either that CC is not happening or that it is not amenable to human action - that reducing our carbon emissions is a sensible precautionary action.
Weitzman (below) says: "The Stern Review is a political document— in Keynes’s phrase an essay in persuasion — at least as much as it is an economic analysis and, in fairness, it needs ultimately to be judged by both standards. To its great credit, the Review supports very strongly the politically unpalatable idea, which no democratic politician planning to remain in office anywhere wants to hear, that (however it is packaged and whatever spin is put on it) substantial carbon taxes must be levied because energy users need desperately to start confronting the expensive reality that burning carbon has a significant externality cost that ought to be taken into account by being charged full freight for doing it. (This is the most central “inconvenient truth” of all, which was conveniently ignored in Al Gore’s award-winning film.)
An entire chapter 22 in Stern, entitled “Creating a Global Price for Carbon,” is devoted to this theme. As the Review puts it, “the pricing of carbon, implemented through tax, trading, or regulation,” is “required for an effective global response” (p. xvii). One can only wish that U.S. political leaders might have the wisdom to understand and the courage to act upon the breathtakingly simple vision that steady pressure from the predictable presence of a high carbon price reflecting social costs (whether imposed directly through taxes or indirectly via tradable permits) would do more to unleash the decentralized power of capitalistic American inventive genius on the problem of researching, developing, and finally investing in economically efficient carbon-avoiding alternative technologies than all of the piecemeal command-and-control standards and patchwork subsidies making the rounds in Washington these days."

Contrast this, though, with a 'give-away' remarks by Nordhaus (below): "How convincing is the Review’s argument for its social welfare function, consumption elasticity, and time discount rate? To begin with, there is a major issue concerning the views that are embodied in the social welfare function adopted by the Review. The Review takes the lofty vantage point of the world social planner, perhaps stoking the dying embers of the British Empire, in determining the way the world should combat the dangers of global warming. The world, according to Government House utilitarianism*, should use the combination of time discounting and consumption elasticity that the Review’s authors find persuasive from their ethical vantage point."
* The phrase is due to Amartya Sen and Bernard Williams (1982, p. 16), which they describe as “social arrangements under which a utilitarian elite controls a society in which the majority may not itself share those beliefs.” Dasgupta (2005) discusses Government House ethics in the context of discounting. [Sen, Amartya, and Bernard Williams, eds. 1982.
Utilitarianism and Beyond. Cambridge and New York: Cambridge University Press; Dasgupta, Partha. 2007. “Commentary: The Stern Review’s Economics of Climate Change.” National Institute Economic Review, 199: 4–70.]

The Bottom Line?
In the simplest of possible terms, burning up fossil fuel reserves, which took millions of years to lay down, in 3 - 500 years is clearly going to affect substantially the planet's carbon balances and cycles. These affects are practically certain to affect the planet's bio-physical characteristics, and very probably for the worse compared to our known histories and experience.

Action (or not) on Climate Change is (in no particular order):
  1. a choice about the future versus the present, especially about our childrens' and their childrens' life chances and opportunities ("the enormously unsettling uncertainty of a small, but essentially unknown (and perhaps unknowable), probability of a planet Earth that in hindsight we allowed to get wrecked on our watch.", Weitzman, below, p722). Inter-temporal choice (decisions and actions with effects across time) under extreme uncertainty (hardly even reducible to any sort of 'probability') is at the heart of the issue.
  2. a choice about what precautions to take (what insurance to hold), rather than a choice between alternative productive investments (which is a perspective that, perhaps, better reflects the rich point of view rather than that of the less advantaged).
  3. a choice about distribution - the spread of costs and benefits amongst people with very different capacities and capabilities to cope and adjust. Who is affected and how they can cope is critical. It is, perhaps, commonly assumed that the richest 20% of the planet's population will be able to cope, albeit at a cost, with more or less anything that CC can throw at us - we are rich, inventive and ugly enough to take care of ourselves whatever the circumstances (- hence the speculative/wealth accumulation perspective).  But this clearly does not hold for the other 80%, who are likely to be much more concerned about the possibility of catastrophe).
  4. a Social (collective) choice about a public good (bad) at the global level (our global climate system, with which we and our children will all have to live) - which requires, at bottom, a common world view and associated action, which is, therefore, necessarily a political choice, and clearly requires global leadership (pace Nordhaus above) and global governance.
So? 
  1. Some sort of 'discounting' is inevitable (1), in order to make comparisons between the welfare of future generations versus that of the present - "the interest rate" matters. But what rate? Or, is it even sensible to think that one single rate (or just 3 over 300 years) is satisfactory?  In particular, appeals to 'evidence' from present apparent decisions about what to save (and invest), and what to spend are largely irrelevant to this question, which relates specifically to inter-generational choice concerning, especially, the future generations' scope for action or capabilities. ["It must be emphasized that the variables analyzed here (the Ramsey equation) apply to comparisons over the welfare of different generations and not to individual preferences. The individual rate of time preference, risk preference, and utility functions do not, in principle at least, enter into the discussion or arguments at all. An individual may have high time preference, or perhaps double hyperbolic discounting, or negative discounting, but this has no necessary connection with how social decisions weight different generations. Similar cautions apply to the consumption elasticity." Nordhaus, below, p 691]. I conclude that the disputes about the appropriate choices of values in the Ramsey equation are largely beside the point. Indeed, the framing of the debate in terms of the Ramsey equation is, I suggest, more confusing than illuminating.
  2. This conclusion  is re-inforced by (2) - the choice here is about precautionary 'investment' behaviour, rather than speculative (accumulation) behaviour - which strongly suggests that we are not here concerned with so-called 'consumption smoothing' (wealth accumulation) calculus, but much more about 'catastrophe' insurance under extreme uncertainty - what does the extreme case look like, and how badly do we need to try and avoid it? Here, Weitzman (below) points out that concern over a highly uncertain future substantially alters the necessary calculus. ["The overarching problem is that we lack a commonly accepted usable economic framework for dealing with these kinds of thick-tailed extreme disasters, whose probability distributions are inherently difficult to estimate (which is why the tails must be thick in the first place). But I think progress begins by recognizing that the hidden core meaning of Stern vs. Critics may be about tails vs. middle and about catastrophe insurance vs. consumption smoothing.", Weitzman, below, p 723].
  3. So, I conclude that SR is 'near enough for farm work' - its concentration on the more extreme possibilities of damage from CC is justifiable on precautionary grounds, as is the choice of relatively low discount rates, while the additional weight given to the less advantaged is also justifiable (not least because these people can be expected, one way or another, to try and hold the "west" to account, and the ways they choose, given that they have little to lose, may prove extremely uncomfortable to the 'west'.) But, perhaps, SR is overly optimistic about the costs of doing something, especially immediately.
  4. But, the need to do something, and to start doing something rather strongly positive now, seems inescapable. Which means that (4)  is the key problem.  Kyoto is a start, but only a small start. The Bali Roadmap is the next and important step. Carbon trading (see below) offers a good chance of generating the appropriate signals and incentives to reduce GHG emissions and minimise the costs of mitigation, as well as providing a mechanism for assistance to developing countries to cope and adapt. For it to work requires a substantial increase in global governance. Without this, the prospects for the future of the human race must remain in doubt.  But it also requires that the global cap of carbon emissions is set at the right level - too high and it will be useless, too low and it will be excessively costly -
  5. A T3 Tax:  In the light of these arguments, the McKitrick (op cit., p 15ff, and also here ) proposal makes very considerable sense -a T3 Tax:  impose a carbon tax whose value is tied to the mean temperature of the tropical troposphere,  If the mean tropospheric temperature starts going up, the T3 tax would go up, forcing emissions down. If the tropical troposphere does not warm up, the tax won’t go up, nor should it. McKitrick suggests setting this tax initially at 20 times the average TTTemperature, which would mean the current tax rate at about $5/tC (about $1/barrel oi) Ross McKitrik says: "The IPCC predicts a warming rate in the tropical troposphere of about double that at the surface, implying about 0.2 to 1.2 degrees C per decade in the tropical troposphere under greenhouse forcing scenarios. That implies the tax will climb by $4 to $24 per tonne per decade, a more aggressive schedule of emission fee increases than most current proposals. At the upper end of warming forecasts, the tax could reach over $200 per tonne of CO2 by 2100, forcing major carbon emission reductions and a global shift to non-carbon energy sources." (quoted from R. McKitrik, 2007)
Meanwhile, remembering that Stern reported in October, 2006, having been commissioned to report in July, 2005,  world oil prices have since done a lot of Stern's  suggested action since then, and will continue to do so, so long as world oil prices remain closr to $100/barrel than to $40/barrel.
Brent Crude Oil Price ($/barrel)Source:  Thisismoney.co.uk

Notice:  2005 - 6 price is about $55/barrel.  Stern's estimate of the cost of climate change (if we do nothing) is about equivalent to a tax of $85/barrel ($315/tC). In other words, we could afford to pay up to $130/barrel and be better off, so long as the higher price for oil actually reduces the damage from climate change. Other estimates are lower, at about $200/tC or an equivalent tax on oil of $47/barrel.

The recent fall in oil prices, from a peak of $145 to $80 reflects the market's view of the likelihood of a global recession (and hence reduced oil consumption), perhaps coupled with some response already to high oil prices in terms of reduced consumption per $GDP.

The 'first' major oil price spike in the early 1970s, following the formation of OPEC in response to the Yom Kippur war, and the US support of Israel, was partly responsible for triggering a sustained period of inflation (25% + in the UK and US for more than 2 years) and consequent rise in unemployment - the stagflation of the 1970s. But it also triggered a substantial improvement in the rate at which the world consumes fossil fuels (and thus emits carbon) - see Independent Summary for Policy Makers (ISPM) of the IPCC 4th Assessment Report  (p.11) - ISPM-2, which relates to fossil-fuel carbon emissions, and does not include GHG emissions from simply breathing (about 1 tonne per person per year), or from the production of food and fibre resulting in land use changes (about 0.2tC/person/year) - both of which are clearly related to the size of the global population.  In short, at present, virtually all the increase in carbon emissions are the  result of more people on the planet, rather than more profligate use by each of us.
See source)
PerCapitaCarbonEmissions


References
W. Nordhaus, "Review of Stern Review", Journal of Economic Literature, XLV, Sept, 2007, 686 - 702
M. Weitzman, "Review of Stern Review", Journal of Economic Literature, XLV, Sept., 2007, 703 - 724.
R.S.J. Tol & G. W. Yohe, "Review of Stern Review", World Economics, 7, (4), Oct - Dec, 2006, 233 - 250
R. M. Carter et al, and I. Byatt et al., "The Stern Review: a Dual Critique", World Economics, 7, (4), Oct - Dec, 2006, 165 - 232.
K. Arrow, "Global Climate Change: a Challenge to Policy", The Economist's Voice, www.bepress.com/ev, June, 2007

Carbon Accounting & Pricing

An aside on Biofuels:

The pitfalls of Carbon Accounting (the practice of accounting for the carbon, (and other greenhouse gas) emissions so as to be able to take steps to limit these emissions) are, perhaps, well demonstrated in the short history of biofuels.

Initially, the general enthusiasm (reflected in various government targets for replacing fossil fuels with biofuels) was apparently predicated on the notion that the carbon released by burning biofuels would be re-captured by the plants producing the fuel, hence producing an essentially 'carbon-neutral' footprint - following farily conventional 'carbon accounting' rules.

BUT: 
More intelligent assessment of the biofuels argument (actually provided by the market) strongly suggests that in many cases the actual carbon savings are, in fact, trivially small at best and strongly negative at worst - and, furthermore, tend, through the price and commodity market effects, to both increase the costs of food, especially to the poorest, and also lead to stronger incentives to convert uncultivated land and natural resources (forests) into production - destroying  existing carbon sinks.  In short, partial accounting of carbon flows, without pursuing the full ramifications of alternatives and counter-factual situations (what would otherwise occur) is bound to be both incomplete and potentially misleading, whatever the conventions adopted for such accounting.  Nevertheless, there are still some considerable enthusiasts.  However, as a recent CARD report from the University of Iowa (Iowa Ag Review, Fall 2007, 13 (4) concludes (my emphasis added):

"Policy Choices:  If, as seems likely, we are entering  a future where policy incentives will be skewed toward rewarding  production activities that reduce  greenhouse gas emissions, then it  is important for the U.S. biofuels  industry to take steps to ensure that  they are providing low-carbon fuels.  The key factors determining carbon  emissions for corn-based ethanol  are (1) whether coal or natural gas is  used to power the ethanol plant, (2)  whether distillers grains are dried or  sold wet, and (3) whether expansion of corn acreage comes mainly  from reduced acreage of lower-value crops or if idled land is brought  into production.  The first of these factors  is largely under the control of  ethanol plant owners. Not drying  distillers grains is feasible only if  large beef feedlots or dairies are  located near the ethanol plants.  State and local policies that encourage strategic siting of cattle operations can greatly enhance  ethanol’s low-carbon credentials.  The last factor is beyond the control of industry. Conversion rates  of idled U.S. cropland can be reduced by increasing domestic conservation incentives, such as CRP  rental rates. But this policy decision creates a dilemma: if U.S. land  is kept idle through higher conservation payments, there will be a  larger impact on crop prices and a  greater incentive for farmers in other countries to expand production.  If this overseas production were to  involve conversion of substantial  amounts of idle land that would  otherwise never be brought into  production, then U.S. corn ethanol  likely would not be able to lay claim  to the title of low-carbon fuel." 

A subsequent working paper (Implied Objectives of U.S. Biofuel Subsidies, Ofir D. Rubin, Miguel Carriquiry, Dermot J. Hayes, February 2008  [08-WP 459]) concludes, inter alia: "Biofuel subsidies in the United States have been justified on the following grounds: energy independence, a reduction in greenhouse gas emissions, improvements in rural development related to biofuel plants, and farm income support. The 2007 energy act emphasizes the first two objectives. In this study, we quantify the costs and benefits that different biofuels provide. We consider the first two objectives separately and show that each can be achieved with a lower social cost than that of the current policy. Then, we show that there is no evidence to disprove that the primary objective of biofuel policy is to support farm income."

See, also, OECD Policy Brief:  Biofuels for Transport: Policies and Possibilities (Nov. 2007)
And the FAO, State of Food and Agriculture, 2008:  Biofuels: Prospects, Risks and Opportunities.

Carbon Accounting?

Life Cycle Analysis (LCA):   LCA is supposed to conduct a fair assessment of the environmental impacts of a product taking into account all of the processes throughout the product’s lifespan, including the extraction of raw material, the manufacturing processes that convert raw material into the product, and the utilization and disposal of the product.

Consider a country that expands production of an agricultural feedstock to produce biofuels. To understand how biofuels affect GHG emissions requires analysis of the GHG contents of all the inputs used to produce the feedstock as well as the inputs used to create the fuel from the feedstock. This is as far as most LCAs go.

But expanded production of the feedstock does not just magically happen. Either:

The Aldersgate Group has recently produced a report: "Carbon Costs: Corporate Carbon Accounting & Reporting Report", which, according to the Environmental Association for Universities and Colleges, "argues that a lack of a standardised carbon accounting system is impeding the UK Government’s long term goals of reducing emissions and creating a low carbon economy. It finds that very few FTSE 350 companies have credible carbon reporting mechanisms in place, and those companies that do could not be compared because they calculated emissions differently."

So What for Climate Change?

A World Carbon Tax? Increasing the price (cost) of emitting GHGs by taxing activities which produce them is the most obvious answer to the global externality of global warming. Taxing emissions would, effectively, internalise the externality, and require everyone to take account of their effects on the climate in all their actions and activities. But, setting such a tax at an appropriate level to apply world-wide is, perhaps, practically impossible. As the Stern Review says: "However, the international harmonisation of carbon taxes can be extremely difficult in practice. Seeking an internationally uniform tax would preclude national discretion about ways of implementing environmental goals; and this may conflict with national sovereignty and the practical politics of domestic policy formation. There are also practical and political challenges in creating large-scale flows to poor countries, to support an equitable distribution of effort, through public budgets alone." (SR, Chap 22, p 470).

Carbon Trading? A possibly more practical alternative is to agree a total global target for GHG emissions as a global limit - which should be agreed for the forseeable future.  Take, for example, the SR presumption that we need to aim at reducing global emissions to 20GtCO2e by the end of this century (SR, Summary for Policymakers, Figure 2, p xii), from a present total of 40Gt rising to 60Gt by 2020.  Suppose all countries can agree (through progressing the Bali Roadmap) on this overall objective.  Countries now need to agree to a distribution of these global targets over time amongst themselves - not an easy task, but perhaps more realisable than agreeing a global carbon tax rate, again possible through progressing the Roadmap.

The Principles:  Suppose, as a starting point, we distribute the 2020 target of <60GtCO2e across countries according to a simple average global per capita target times each country's population (approx. 9t/head). ("The ‘growth-needs’ approach applied simplistically suggests distribution on an equal per capita basis" (SR, Ch 22, p 473/4). We need also to agree how these limits will be progressively reduced to achieve the target of 20Gt by 2100 (2.2t/hd at a projected world population of 9 billion). We need to reduce per head emissions by 7t/head over  this century (effectively, given the time necessary to reach agreement, over 70 - 80 years, or approximately by 1 tonne per head per ten years). Each country would agree to the associated limits on national emissions, progressively reducing as we approach 2100, and each would be obliged to take the necessary steps to achieve these targets (subject to international sanctions of various sorts - such as monetary fines or trade retaliations - and subject to an international authority charged with monitoring emissions and developing/implementing a common system of carbon accounting). One obvious (though not necessarily simple) way any country might do this is to further allocate their national quota to (in principle) everyone in the country (establishing a carbon ration for everyone in the country).

As well as being required to file a tax return every year, each household could, under this general principle, be required to file a carbon account every year as well (the organisational and institutional problems should not be under-estimated!), In effect, every person has a carbon ration book, and must make their carbon account balance (subject to penalty). If they exceed their ration, they must get (pay for) some additional ration.  If they have spare rations, they can sell them to those who need them.

One can imagine a global market in carbon rations - with the rich buying from the poor, and establishing a market price for carbon in the process, which would reflect the costs of mitigating emissions to achieve the global and associated national targets, and encourage greater efficiency in using carbon.

The Practice?  Of course, such a system would be impossibly difficult (expensive) to contemplate in practice (except, perhaps, by the end of this century).  However, the bulk of at least CO2 emissions are generated (in the first instance) by power companies and fuel distributors (as well as by those responsible for the burning or exploitation of standing forests, wetlands etc.).  It is not beyond possibility that these relatively few and very large players (businesses) should be required to meet their 'share' of the global and national quotas and to balance their 'share' of the associated rations.  Once established, these companies would be expected to trade their emission rights (quota), and so establish a price for carbon reflecting the costs of achieving the targets, and encouraging the minimisation of these costs. International emissions trading is already allowed for and sanctioned under the Kyoto protocol (e.g SR, Ch 22, p 476, which also outlines other emissions trading systems in operation already, including the EU's emission trading scheme (which fell foul of the basic error when first introduced that the overall quota limits were set too high, with the result that the emissions quotas were virtually valueless - there was no price to be paid for carbon emission rights).  As Stern says:

"A global quantity constraint can be used to drive intergovernmental trading of emissions quotas, and this has already been adopted within the current multilateral framework, the Kyoto Protocol. Moreover, as we explained in Chapter 14, a key benefit of trading schemes for emissions quotas is that they allow the cost-effectiveness (via a common price) and distributional equity of action (via flows based on quota allocations) to be managed separately but simultaneously. In a global and comprehensive system of quota trading, the initial allocation of national limits on emissions affects the distributional equity of the scheme, but not the equilibrium distribution of emissions reductions, the market-determined carbon price or the costs of abatement." (SR, Chap 22, p 471)

"There is no single formula that is likely to capture in a satisfactory way all relevant aspects of an equitable distribution of effort between countries across the various dimensions and criteria – but the criteria tend to point in similar directions" (rich countries taking a greater share of the costs of mitigation, but not necessarily the same arrangements or rules for sharing those costs). (SR, Chap 22, p 473 - 4)

"Nevertheless, the concepts underlying the Protocol – in particular, the aspiration to create a single, efficient carbon price across countries through the use of emissions trading and the recognition that mechanisms are required to make finance and technology available to poor countries on the basis of equity – are very valuable. These are elements to be strengthened within any future regime for action on climate change." (SR, Ch. 22, p 478)

How might we get there from here?  This is the critical problem, from this perspective. The next 20 years are vitally important - which is the time it will take to get the planet's house in order if we are to meet this global challenge. It is in this sense, I suggest, that the urgency pervading the Stern Review (in contrast to the conventional economic prescription of starting slowly and 'ramping up') is to be understood - as a political problem rather than a strictly economic problem - the need to convince politicians, and their constituents, of the urgent need to (plan to) do something serious.

So, agree on the above outline - essentially the 2030 - 2100 global totals and distribution of carbon quota, and the principles of carbon trading, and then agree on a phased transition to this system from now until 2030 - by, perhaps, an initial quota allocation which progresses from the indicative Kyoto allocations to the 2030 "equitable" allocations, which would allow some growth ceilings for developing countries, but also some hard limits for the developed world. So long as these limits in the developed world are hard enough to generate a serious and increasing carbon price, the developed world and its businesses can be relied upon to develop the necessary carbon trading systems and practices, and the necessary common carbon accounting systems that go with them.  Once in place, these can then readily be extended to the rest of the world.

But, without a common aim and strategy being agreed, nothing sensible will happen.  It is getting very close to being too late to do anything serious. We stand in danger of wrecking the planet, and our descendants (if we have any who survive) will not forgive us that.

What Next?

The UK Government is introducing a Climate Change Act, and has committed the UK to carbon reduction (via the Energy White Paper, 2007) under its Carbon Reduction Committment,  and now requires all government appraisals to account for the costs of carbon:  "We use the shadow price of carbon (SPC) to value the increase or decrease in emissions of greenhouse gas emissions resulting from a proposed policy. Put simply, the SPC captures the damage costs of climate change caused by each additional tonne of greenhouse gas emitted, expressed as carbon dioxide equivalent (CO2e) for ease of comparison. The new guidance brings the value of carbon included in appraisals into line with the Stern Review’s assessment of the social cost of carbon. The SPC is different from the previously used social cost of carbon (SCC) in that it takes more account of uncertainty and is based on a stabilisation trajectory."This paper represents the current (Feb, 2008) position of the UK government on carbon pricing in government related assessments of projects and programmes, and includes a schedule of indicative carbon emission shadow prices to be attached to carbon emissions from 2000 to 2050. These begin at £26/tCO2e in 2008 and increase to £60/tCO2e by 2050. These figures, @ $1.8/£, and 3.7tC/tCO2e, to $173/tC, (or $45/barrel) in 2008, to $400/tC ($108/barrel) in 2050.  We had better get used to higher priced oil, and also to higher priced food and water.

BUT James Lovelock strongly believes that we are living in genuinely chaotic systems, which are already far-from-equilibrium, and that all attempts to model these systems, for forecasting or projection purposes especially, are futile and bound to be wrong. Climate change is now inevitable, no matter what we do - there is no going back once we pass the 'tipping point' or 'phase change', any more than it is possible to go back once you have fallen off a cliff, or begun to roll down a progressively steeper hill - there comes a point when it is no longer possible even to hang on. "In a sense, since we are part of the whole system, you can say we are the consciousness of the planet. We are part of it, we can never consider ourselves as something separate. To think we could be its stewards is grotesque. We will be struggling against it. We've got to make peace while we're still strong enough to make terms, and not just a rabble. I see Kyoto as like Munich. It's an attempt to buy time before the real struggle starts." (Guardian Interview, 2005)  So, all we can do is prepare for the worst - which means getting as much energy as we can while we can (including, especially, nuclear energy) and, possibly, slowing the processes down a little (by, possibly, polluting the upper atmosphere again with sulphur in jet fuel to reduce the warming effect).


Comments and Questions to David Harvey?

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